Investors are in the dark about the Fed's decision this week - and that's just how Warsh wants it

By Greg Robb

Will Kevin Warsh support a rate hike? Fasten your seat belts for the decision on Wednesday.

Five days before the Federal Reserve's interest-rate committee meets, there is a lot of uncertainty about what the central bank will do.

Markets see a one-in-three chance of a rate hike in July, with most on Wall Street expecting that the central bank will wait until September.

Fed watchers say this is the most uncertain the market has been about a rate decision in years.

Welcome to the "regime change" promised by Kevin Warsh, the new Fed chair.

"We are really seeing in market prices the imprint of the new chair," said former Minneapolis Fed President Narayana Kocherlakota, now a professor of economics at the University of Rochester.

"This is the kind of regime change he wants to see - where people don't know what the Fed is going to do. And then the Fed is free - they can keep rates the same or raise rates," Kocherlakota said.

Without a guiding hand from Warsh, investors and Fed watchers should pay closer attention to the rest of the members of the Fed board of governors to get a sense of interest-rate policy, Jim Bianco, president and macroeconomic strategist at Bianco Research, said in an interview.

"Warsh is not the guy who drives the bus anymore. We have 12 independent voters. The chairman is one of 12," he said.

Fed officials will meet on Tuesday and Wednesday to discuss interest-rate policy. The central bank will release a decision statement at 2 p.m. Eastern time on the second day of their meeting, and the Fed has scheduled a press conference with Warsh at 2:30 p.m. that day.

Fed officials supporting hikes have conviction

Officials will be contending with a challenging picture. Inflation has been above the Fed's 2% target for over five years, and the Iran war has pushed prices higher in the first half of the year.

Just weeks ago, it looked like a ceasefire in Iran might lower pressure on oil prices in the second half of the year. But renewed fighting may change the equation for the Fed.

Many Fed officials have made clear in their public comments that they are impatient and want the central bank to raise rates. Dallas Fed President Lorie Logan and Cleveland Fed President Beth Hammack have been arguing for months that the central bank should consider hikes.

On the other side, officials including New York Fed President John Williams think the Fed can delay hikes to see how inflation unfolds.

"Fed watching has now become vote tallying, understanding the stance of each voter," Bianco said. That's a departure from previous eras of the Fed, when going into a meeting it was relatively certain that the chair would be backed by the majority of the board.

At the moment, Bianco sees five votes to hike rates - two short of the seven votes needed.

But the minority in support of hikes "has a high level of conviction" and may be able to persuade colleagues who are on the fence to join them, said Neil Dutta, head of economic research at Renaissance Macro Research, in an interview on Bloomberg Television.

At the very least, some officials will almost certainly dissent in favor of hiking. This week marks the first meeting where other members of the board will push back, economists said. There were no dissents at the June meeting, Warsh's first as chair, as central-bank officials gave him a "honeymoon" that isn't expected to last, said Derek Tang, co-founder of LH Meyer/Monetary Policy Analytics.

Will Warsh back a hike?

It is not clear how Warsh wants to approach rates at this meeting. He hasn't given any insight into his own thinking about the economy or where interest rates should go.

During his two days of testimony to Congress earlier this month, Warsh was "cryptic at best" in terms of his views on interest-rate policy and inflation, said Gregory Daco, chief economist at EY-Parthenon.

Warsh didn't offer his views on critical topics for investors, including where he thinks the inflation rate is heading, whether he believes inflation will soften going forward or any views on whether the artificial-intelligence investment boom is inflationary in the short run.

"These are all topics that the Fed chair should be addressing," Daco said in an interview with Bloomberg. "I'm thinking that he's trying to hide in some ways behind the committee."

Could the committee decide to hike and bring Warsh along? It seems possible, Bianco said. Warsh has talked tough on inflation, so it seems he could easily support a rate hike if he wanted to.

If Warsh decides he supports a hike, the vote by the Fed's interest-rate committee could be 10-2, Bianco said.

On the other hand, Dutta said, Warsh could probably get the committee to back holding rates unchanged in July. But it might be smart for him to back a hike in July rather than being forced by his committee to hike in September, Dutta added.

Many economists don't think Warsh wants to hike and expect the Fed to remain on hold all year.

They point out that when Warsh was campaigning for the job of Fed chair, he seemed to favor cuts. The White House has been pushing for the Fed to cut interest rates for months.

President Donald Trump seems aware that Fed officials are approaching interest-rate policy independently of Warsh's views.

In a recent interview with the Fox Business Network, Trump indicated that he understood Warsh was one vote on the committee.

"I have a lot of respect for him. Don't forget, he has a board. Maybe it's hostile. It could be hostile. And maybe it's people that don't want to do what's the right thing," Trump said.

This comment seems designed to set the blame for any tightening on other Fed members. Still, reminding investors that the chair is just one vote makes Warsh look weak, said Tim Duy, chief U.S. economist at SGH Macro Advisors.

Warsh can't immediately count on support from his board

As he starts his term as Fed chair, Warsh can't count on the support of his fellow governors for his agenda, Bianco said.

Dissents from governors have been extremely rare since the mid-1990s. The chair was always able to negotiate support from his six fellow governors.

Former Fed official Kocherlakota said there has been deference shown to the views of the chair, but it was not automatic support.

"Fed chairmen don't get those seven votes just by showing up," he said. Instead, they have to talk to their colleagues and persuade them that a given decision is in the interest of the economy.

Kocherlakota, who served on the Fed board with Warsh for more than a year in 2009-10, said he "was always impressed with his intelligence. But he has to translate that force of his mind into the intellectual arguments, and then he will start to have sway on the committee."

Over time Warsh may get that deference, but for now it's "early days" for him, Kocherlakota said.

A very interesting voter is Jerome Powell, who remained on the Fed board after his term as Fed chair ended in May so that he could continue to defend himself from Trump's legal attacks.

Bianco said a divided Fed could be Powell's "nightmare scenario," because if the Fed committee is divided, he might cast the deciding vote. Powell said he was going to "keep his head down" as a governor, and this would thrust him into the spotlight.

In the end, Kocherlakota said the Fed had room to keep rates unchanged in July, with the cool consumer inflation data in June supporting a "wait-and-see" stance.

"But over the course of the next two or three meetings, I think the Fed is going to have to hike to preserve what I think is its true credibility, which is its independence from the White House," he said.

-Greg Robb

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